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Litigation has cast a long shadow over
Transocean RIG -4.946236559139785%Transocean Ltd.U.S.: NYSEUSD13.26
-0.69-4.946236559139785%
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13023143AFTER HOURSUSD13.26
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Volume (Delayed 15m)
:
155892
P/E Ratio
N/AMarket Cap
4630612889.76558
Dividend Yield
4.524886877828054% Rev. per Employee
N/AMore quote details and news »RIGinYour ValueYour ChangeShort position
since the 2010 Gulf of Mexico spill. But the final stages of the legal drama should unfold next year, and odds seem good that the company can fund any payments required. Shares of the oil-rig operator could surge as investors again focus on fundamentals, the deepwater-drilling market strengthens, and Transocean's operations improve.

"The demand for [deepwater] rigs is dramatically higher than supply," says Jerry Furciniti, a portfolio manager at QCI Asset Management, which owns Transocean shares. If, as Furciniti expects, the company can earn $5 a share in 2013, Transocean stock (ticker: RIG) could be worth $60 in a year. That's significantly above its recent price of $46 but well below $92, where it traded before the Gulf accident occurred. Transocean is expected to generate $3.47 a share of earnings this year, on $1.2 billion of net income and $9.7 billion of revenue.

But before investors can focus on Transocean's fundamentals, they must untangle the web of litigation surrounding the Swiss company. Transocean owned the Deepwater Horizon, the rig that exploded and sank in spring 2010, atop a well that spewed almost five million barrels of petroleum into the Gulf over 87 days.

BP was responsible for monitoring the gas. But, says David Uhlmann, a law professor at the University of Michigan: "There's no question BP, Halliburton, and Transocean were negligent, and [that all] should face criminal charges under the Clean Water Act. Transocean provided the rig to drill the well. It had a responsibility to ensure that BP acted in a safe manner." If Transocean thought BP was acting in a risky manner, Transocean should have refused to carry out BP's directives, he adds. Also, a Coast Guard report has questioned whether some of Transocean's equipment was properly maintained.

Hundreds of suits involving the Gulf spill have been consolidated in one court in New Orleans. The civil trial is slated to start in February, but attorneys Barron's spoke with expect a settlement. "There is a strong chance Transocean won't have to litigate this. There's too much risk for both sides," says Tom Claps, a litigation analyst at Susquehanna Financial Group. He pegs the company's liability at $2 billion to $3 billion.

This fall, Transocean reported that it had discussed a $1.5 billion settlement with the Justice Department, but no deal was struck. The company said it continues to view its $2 billion reserve as adequate for any payments stemming from the Deepwater Horizon disaster. Overall, the company has $6 billion of cash and $14 billion of debt. Justice Department officials declined to comment on the case.

BP, which settled a criminal lawsuit with the government last month for $4.5 billion, has taken a $42 billion charge for what it estimates will be the total costs related to the spill and has been selling assets to help pay the huge tab. Last week, it was barred from bidding on new U.S. contracts to drill in the Gulf of Mexico. The ban will stay in effect until BP proves it meets federal business standards.

Transocean hasn't been criminally charged, but neither was BP until it announced its settlement. In any event, any criminal or civil settlement by Transocean would be much lower than BP's, since BP bears far more responsibility for the spill and is much larger, Uhlmann asserts.

TRANSOCEAN'S LIABILITY is largely limited by an indemnification clause in its contract with BP. Transocean contends this limits its liability to problems on or above the ocean surface—not a leak from the Gulf's floor. BP, however, is suing Transocean, claiming breach of contract, unseaworthiness, negligence, and gross negligence.

In January the indemnification was upheld in a ruling in the U.S. District Court for the Eastern District of Louisiana. The court found that the indemnification held, even if the damage below the water's surface was due to Transocean's liability, negligence, or gross negligence.

However, BP doesn't owe Transocean indemnity from civil penalties imposed under the Clean Water Act, and those penalties could be substantial: $1,100 per barrel leaked if the company is found guilty, and $4,300 per barrel if gross negligence is found. Susquehanna Financial's Claps, however, believes the judge can use a lower number for parties considered to bear less fault for the accident.

The indemnification clause also doesn't protect Transocean from having to pay punitive damages. The judge also didn't rule on whether Transocean had breached its drilling contract with BP or materially increased BP's risk, thus invalidating the indemnity clause.

In Transocean's most recent earnings conference call, CEO Steven Newman said "the favorable rulings we have received from the trial court on our insurance, our contractual indemnity from BP, and our standing under the Clean Water Act and Oil Pollution Act, emphasize the strength of our case."

Transocean also faces civil litigation in Brazil in connection with a 2011 oil leak involving one of its rigs. The prosecutor is seeking the equivalent of $10 billion from it and
ChevronCVX -4.890895410082769%Chevron Corp.U.S.: NYSEUSD88.48
-4.55-4.890895410082769%
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18833469AFTER HOURSUSD88.51
0.030.033905967450271246%
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229912
P/E Ratio
13.675425038639876Market Cap
166384702172.015
Dividend Yield
4.837251356238698% Rev. per Employee
2421550More quote details and news »CVXinYour ValueYour ChangeShort position
(CVX), the well operator, and wants them barred from working in Brazil. But this fall, Brazil's Superior Court of Justice let the companies work in Brazil, although not on the site of the leak. Chevron has agreed to indemnify Transocean for any fines relating to sub-water-surface pollution. Chevron also is assuming Transocean's defense in the lawsuits.

Despite the legal clouds, the fundamentals have improved for Transocean and its industry. Although oil has fallen from north of $100 a barrel to the high $80s, it's still high enough to warrant the high costs and risks of deepwater drilling. And Transocean is one of the handful of companies with equipment capable of drilling in the deepest waters.

The Bottom Line

Transocean shares are in the mid-$40s, well below their level before the Gulf of Mexico oil spill. Bulls think they can rise by a third over the next year.

The deeper a rig can drill, the higher the price it usually fetches. Last quarter, Transocean's rigs had average daily revenue of $395,100, up from $388,800 a year earlier. New contracts on ultra-deepwater rigs are going for $600,000, says QCI's Furciniti. Those rigs account for 33% of its 82-rig fleet and there are six similar ones under construction. Drilling revenue rose 26% in the third quarter, to $2.3 billion, from the year-earlier quarter's. At the same time, Transocean has sold some shallow-water rigs that fetch low day rates. At a recent conference, Newman said that, as leases expire, rates for 37% of the company's ultra-deepwater fleet could be repriced in 2014, rising to 57% in 2015.

Over the past two years, the company has been recertifying some blowout-preventer equipment, forcing it to pull rigs out of service. But as that program winds down, its rig-utilization rate has risen, to 77% in the September quarter from 63% a year earlier. This helped operating margins jump to 30.9% from 12.2% in the same span. Still, Morningstar analyst Stephen Ellis, who pegs the stock's fair value at $67, thinks the company's long-term earnings potential is $5 to $10 a share from its rigs.

All in all, it's a gusher of good news that should boost Transocean stock when the still-oozing damage from the Deepwater Horizon litigation finally is capped.